Prompt Pay Act Applies to Duty to Defend Claims

Historically, courts have applied different duties to insurers in the context of third-party claims versus first-party claims.  “First-party claims” are those where the policyholder is seeking to gain a financial benefit from the policy in question.  “Third-party claims” are those where a third party, someone not a party to the insurance contract, are seeking the benefits of the policy.  Typically, those claims arise in the context of liability insurance.  But what happens when an insurer refuses to defend or indemnify its insured for a claim made against them by a third party and for which the insured purchased insurance coverage?

The “duty to defend” an insured is triggered by what is called the 8 Corners Rule – the 4 corners of the insurance contract + the 4 corners of the pleading that was filed or demand/notice that was sent.  It is a broad duty aimed at, in the least, providing the defense for the insured.  The general rule is that the insurance company is obligated to defend “the insured in any lawsuit that alleges and seeks for damages event potentially covered by the policy.” D.R. Horton—Texas v. Markel Int’l Ins. Co., 300 S.W.3d 740, 743 (Tex. 2009).  Once the duty is triggered, the insurance company has a duty to defend the entire case, even is some of the alleged injuries are not covered. The insurance company can elect (a) to not defend forcing the insured to retain counsel at its own cost, (b) defend under a “reservation of rights” – meaning they will defend but they are not convinced there is coverage, or (c) defend fully.  When insurers elect (a) it leaves the policyholder in a vulnerable position – they are looking at a third party’s claim against them that they might owe for and, on top of that, they must find counsel and pay them to defend against the allegations.  So, what happens when insurers fail to defend but the claim was covered?  Do the late payment penalties under the Texas Prompt Pay Act apply to those policyholders?  The answer is YES.

In a construction defect case where the liability insurer refused to defend the suit or contribute to a settlement, on review the Texas Supreme Court found the coverage analysis of the lower courts wrong.  See Lamar Homes, Inc. v. Mid-Continent Cas. Co.,242 S.W.3d 1, 16 (Tex. 2007).  And, once establishing coverage, the court held that “defense costs” were solely the claim of the policyholder, hence, a “first party claim” subject to the Prompt Pay Act.  In so doing, the Court relied on a 1991 change to the statute that added the term “first party” to the definition of “claim.”  See Tex.Ins.Code §452.051(2). So, now, when insurers decide not to defend a lawsuit it exposes itself to liability under the Prompt Pay Act, Texas Insurance Code §452.060(a) with its payment deadlines and penalties for late payments.  Those penalties are 18% interest on the amount of the covered late payment, amortized per day, along with necessary attorney’s fees.  To mature the claim, the insured would need to submit its legal bills to the insurance company as it receives them.  For each bill, the deadlines of the PPA apply.

Since the Court relied on specific language in §542.051(2), it is not clear other duties owed by an insurer for failure to tender a defense for covered claim apply.  Generally, Courts have held that duty under a liability policy is limited to the Stowers duty to engage in reasonable settlement negotiations.  It would follow that any claim that the insurer failed to reasonably settle a liability claim would be limited to the Stowers duty.  However, are duties under Texas Insurance Code §541 breached when an insurer fails to defend a covered claim?  Are insured’s entitled to treble damages?  Again, the answer is YES.

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